1 February 2010 
The President proposed his budget today. This is the budget for federal fiscal year 2011, which begins October 1 of this year.
Most people in Washington will focus on (1) the effects of the proposed budget on the deficit and (2) what the budget proposes for specific policies they happen to care about.
I will focus on the size of the proposed budget relative to the rest of the economy. The deficit is an important but incomplete measure of this. It’s important to remember that every dollar not spent by the government is a dollar that can be spent by individuals, families, and firms. We should care not just about the difference between spending and taxes, but also on how big government is relative to the private sector.
Throughout this post I will describe things as a share of the economy (% of GDP). This is a useful way to compare budgets across time but it is biased in favor of bigger government. There is nothing that says that because the economy gets bigger that the government must grow along with it. I’d like to do these presentations in real (inflation-adjusted) dollars to eliminate this bias, but it would make my analysis difficult to compare with almost everyone else’s. For now I won’t fight this and will just use % of GDP.
Deficits
Let’s begin with the deficit. As always, click on any image to see a bigger version.
The green line shows deficits as proposed by President Obama last year. The blue line shows deficits as proposed by President Obama this year. The dotted yellow line shows the deficit consistent with holding federal debt (as a share of GDP) constant. If deficits are above this dotted yellow line, then our debt burden relative to our economy’s ability to pay for it will increase. If deficits are below that line, our debt burden will decline relative to the economy. (I’m oversimplifying a bit – the dotted yellow line should actually slope gradually upward depending on what happens to debt in the intervening years.) For now this maximum is 3.0% of GDP.
We can draw five important conclusions from this graph:
- At 8.3% of GDP, the proposed budget deficit for 2011 is still extremely high.
- President Obama is proposing larger budget deficits than he did last year.
- For 2011, the most relevant year of this proposal, the President is proposing a budget deficit that is 2.3 percentage points higher than he did last year (8.3% vs. 6.0%).
- Using his own numbers, the President’s proposed budget deficits will cause debt as a share of the economy to increase.
- Under the President’s proposal, budget deficits begin to increase as a share of the economy beginning in 2018.
Adding further detail to (4), the President’s own figures show deficits averaging 5.1% of GDP over the next 5 years, and 4.5% of GDP over the next ten years. They further show debt held by the public increasing from 63.6% of GDP this year to 77.2% of GDP ten years from now. I think it’s a safe assumption that CBO’s rescore of the President’s budget will be even worse.
From a macroeconomic standpoint, short-run deficit reduction is contractionary. Reducing the budget deficit toward manageable levels is necessary from a federal fiscal standpoint, but it reduces short-term economic growth. This is the Administration’s core short-term economic policy challenge, the tradeoff between fiscal stimulus and deficit reduction over the next 2-3 years.
Taxes
The green line shows total revenues proposed by the President last year, and the blue line shows this year’s proposal. The dotted pink and red lines show historic averages of the past 30 and 50 years.
You can see that taxes were really low when the President took office, a consequence of the severe recession. The big jump from 2010 to 2012 is a result of several factors all pushing taxes higher:
- as the recession ends, revenues will recover as a share of the economy;
- President Obama proposes to allow some of the Bush tax cuts to expire on December 31 of this year;
- He is proposing some other tax increases as well;
- The tax code has features that build in tax increases over time. The most important is known as bracket creep.
We can draw two conclusions from this graph:
- Taxes are low now, but are scheduled to increase to above historic averages.
- The President is proposing slightly lower revenues over the next few years than he proposed last year, but essentially no difference in the long run.
Spending
I saved the most important graph for last. Every dollar spent by the government must be either taken from someone in the private sector (taxes) or borrowed from the private sector (deficits).
Again, green is last year’s proposal, blue is this year’s proposal, and dotted pink (30-years) and red (50-years) are historic averages.
We can conclude:
- The President is proposing significantly more spending than he proposed last year: 1.8% of GDP more in 2011, and roughly 1 percentage point more each year over time.
- Spending is and will continue to be way above historic averages.
At its lowest point in the next decade federal spending would still be 1.7 percentage points above the 30-year historic average. Over the next decade, President Obama proposes spending be 12% higher as a share of the economy than it has averaged over the past three decades.
Remember that fiscal policy is not just about the budget deficit, the difference between spending and taxes. It’s also about the size of government: how much is the government spending, and therefore taking from the private sector?
Keith,
From a European perspective I would like to ask one question: Many pundits and also Obama noted, that most of the debt was piled upon on your economist's watch plus the legacy of an economy in ruins. Do you think it's fair to blame Obama now for this mess and how to judge your economic advice in retroperspective?
Hi Stephan,
I'm not Keith but I'll try to explain. The Bush budget through 2007 showed a falling deficit largely representative of net interest on the privately held public debt. The primary budget was coming back into balance.
When the recession began the Bush administration was under increasing pressure to undertake a stimulus. Congress passed and the president signed the first stimulus bill. That was for $600 billion in one time payments to individuals. It was ill designed and its effects were short lived. When the financial crisis hit the TARP program was signed into law and most of that spending was a bipartisan agreement. TARP was largely loaded into fiscal 2009 and fiscal 2010. As the recession deepened in calendar year 2008 and 2009 our automatic stabilizers, unemployment insurance, higher utilization of medicaid, foodstamps and other countercyclical mandatory programs kicked in causing the deficit to rise at an increasing rate with the worsening recession. continued in next message
There is growing evidence that government size is negatively related to economic growth. So, the above-average government deficits and spending must inevitably lead to below-average economic growth for the US and probably most of the developed world. On the positive side, chances of convergence of emerging economies seem to be increasing, although the overall outlook for the global economy is somewhat mixed.
If that is true Somalia must be paradise on earth and Sweden like hell. Can you back up your claim: "There is growing evidence that government size is negatively related to economic growth."
Keith:
Matt P is right.
Every deficit dollar is a dollar that the Govt has transferred to the private sector, but not taken back via taxes. Therefore it's a dollar that's available to us — not a dollar that's been taken away!
The problem is that the Govt is busy taking away the few dollars we have when the private sector is desperately trying to rebuild its savings, savings that have been devastated through the stock market crash, the housing crash, and unemployment. And the dollars the Govt is spending are going to well connected cronies, like Goldman Sachs, and not the american family. I think the last tax rebate was for $250. Try feeding a family of four on that!
The Obama administration budget calls for slightly higher deficits in the short term, higher taxes in the long term, and more spending to cronies. This will keep americans unemployed in the short term, push the country back into recession in the long term, and further strengthen Goldman Sachs.
Instead, you should call for a payroll tax holiday, to be kept into effect until unemployment has improved enough that inflation begins to be a concern once more.
Keith — apparent typo in your post: I think you meant to say "above" instead of "about" where you say "If deficits are about this dotted yellow line, then our debt burden relative to our economy’s ability to pay for it will increase."
Keith, re:
There is nothing that says that because the economy gets bigger that the government must grow along with it.
Indeed, and I would guess the opposite — that, other things equal, a growing U.S. economy would mean declining federal spending as a percent of GDP. In other words, it seems to me that — just a hypothetical — if we leave out assumptions of demographic shifts (under 65 vs. 65+), medical inflation, and any other extraneous factors, as the U.S. economy grows it would cost LESS as a percent of GDP for the federal government to provide the same level and quality of each type of "stuff" it currently provides? I say this largely because I assume that (1) only part of the growth would be due to population growth, with the other part growth in GDP per capita, and (2) a substantial amount of federal spending would be fixed or less than fully variable vis a vis population growth (e.g., Defense, some administrative and operational infrastructure, etc.). Are my assumption and reasoning correct?
It's always amusing when I hear "inherited", never state the positives inherited, and forget the spending and massive deficits came under a Democratic congress. And so it goes………..
Hello Keith,
Thank you for your contribution to understanding many of these complex issues. Your healthcare series was particularly interesting. Having said that, I must take issue with this statement: "I saved the most important graph for last. Every dollar spent by the government must be either taken from someone in the private sector (taxes) or borrowed from the private sector (deficits)."
This is demonstrably false but is one of those things everyone assumes to be true. People confuse a money creator (US Government) with a money user (i.e. family, business, etc.). The US Gov. doesn't get its dollars from anywhere. Not from taxes, not from China. It creates them via the banking system. Taxation is actually a method to control inflation and to adjust wealth allocation to create societal goals. There is a whole line of economic thought called Modern Monetary Theory or post-Keynsian.
Your statement assumes we are still in a gold standard environment rather than the fiat system.
If the Gov. creates it's money through the banking system then how is there a deficit? If taxes are not a source of revenue for the government what social goals do taxes achieve? If taxes are used to control inflation where does that money go if it isn't revenue for the Gov.?
Taxes are used to reallocate spendable money across sectors and to provide certain incentives via tax breaks/incentives. I know this sounds crazy but it is my understanding that if you paid your taxes in cash they would literally shred it. Think about it logically…the US Government creates dollars/credit. No one else does. What is the difference if they collect your tax dollar and re-spend it or if they collect it, shred it and create more?
Either the money has to come from taxes or debt instruments if we hold the money supply constant. If the money supply is expanded, it would lead directly to inflation according to the quantity theory of money. So you are implying that the Fed would further weaken the dollar to support spending increases.
So Josh, take a look at our money supply. Where is the inflation? We are in a deflationary environment and will be for some time. How about Japan? This country is not Zimbabwe. As Z. said below, the private sector is trying to rebuild its balance sheet. "Ttoo many dollars chasing too few goods" is the best definition of inflation — dollars have to chase goods for inflation to be an issue. If the Government prints money, and it just gets saved, then, although the money supply has been "diluted" (a la that Austrian school) from a practical perspective, it's like the money doesn't exist at all, since it just sits in checking accounts.
Keith? What say you?
Your response to the comment "Every dollar spent by the government must be either taken from someone in the private sector (taxes) or borrowed from the private sector (deficits)" is demonstrably incomplete. While the government might have the ability to print money, in doing so it takes from the private sector by means of inflation (a form of taxation which results in the loss of private savings).
With Obama's election another stimulus bill was signed into law, about $820 billion (latest estimate from CBO), further increasing the deficit in 2009. The bulk of this stimulus is loaded into 2010. There was also a 15% decline in all government revenues from 2008 to 2009 further increasing the deficit. If we had foregone both stimuls packages the $600 billion lump sum and the $820 billion Obama stimulus we would have had a steeper decline in aggregate demand that could have caused government revenues to fall by an amount greater than the stimului.
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As I read it, the countercyclical spending is about 50% Bush and 50% Obama but actually it is neither. It is autopilot spending. The only major difference here is that Obama is benefiting from a low interest rate environment where net interest has declined by over 50% from the Bush administration. Net interest is the piano hanging by a thread as we are walking under it.
But what of Obama's discretionary spending increases? They account at best for about 20% of the deficit but some of these increases are automatic as well. So, what's a president to do or for that matter a former community organizer to do? Surrender to the autopilot budget and go to Hawaii, often, and don't forget to take off your shirt and walk on the beach.
Seriously, Obama is only left with his regulartory whip and his gift for oratory. Rhetoric and Regulation now that's the ticket.
Steven,
Many thanks for your reply. And sorry for the late answer. It's a problem to reply timely while sitting on the other side of the pond. In regard to stimulus I agree. It's 50:50. But what about two tax cuts and the Medicare prescription drug benefit on Bush's watch? I do not want to blame him for starting two wars. But historically once you start a war either you raise taxes or your issue bonds. To lower taxes is a historical novelty
You might want to have a look at the chart here:
http://baselinescenario.com/2010/02/01/budget-sen…
Personally I think this worry about debt is totally overblown! Whole Europe has a VAT in place and despite US impression we're not impoverished savages. Thus at the end of the day the US government will introduce a modest federal VAT. Problem solved! Here in Austria we've 20% VAT. I think 5-7% VAT would do it for the US. (I'm envious
Stephan,
The basic argument presented by the CBPP could be restated for any cabinet department or federal program. The assumption being that since there is a deficit we can arbitrarily add up at random a bunch of programs that total to the deficit and then calculate the carrying costs of these programs and come up with a shocking number. We could do that for the mortgage interest deduction, the childcare tax credit or the tax exemption for municipal bonds. But at the end of the day this kind of analysis is empty and doesn't tell us anything.
Taking on your other points. The drug benefit has come in below projections and there is some indication that it has reduced hospitalizations for chronic ailments. So I think the jury is still out on its long term impact on Medicare spending.
The tax cuts were increasing federal revenues before the recession and will after the recession ends unless they are allowed to expire. Between 2003 and 2007 tax receipts grew at a 10% compounded rate. If the tax cuts are allowed to continue we should see a similar performance in tax receipts. The share of individual and corporate income taxes could be substantially higher if the tax cuts remain in place.
I would love to see a consumption tax and the elimination of the income tax. But we would need a 20% VAT eventually to service our debt and social insurance programs.
Steven,
I can personally assure you that even with a VAT of 20% you can have a lot of fun and must not sit half-naked in a dark cold room.
All this tax stuff is debatable. My main points in regard to the US debt would be: You can not wage two wars without wading into debt. Never ever has this happened in history. And the tragic thing about these wars is, that even winning them won't bring the normal victory dividend.
Now these two wars are either necessary or not. Can't really decide on that. But then the US is waging two more wars. Both senseless and insane. The war on drugs. Lost since decades for the cost of billions. And the war on terror. Fighting ghosts for no benefit.
The US spending for defense is crazy. The US is making up for the shortcomings in the EU and elsewhere. Why? And why spend now more than in the Cold War? Crazy!
A bit of digression here from the budget. However, defense spending is necessary. We are the only superpower, we have a blue water navy, the only one in the world. We keep the sea lanes open. We are there to keep the oil choke points open. Our defense spending benefits the world. Our military is our state department. Our officer corps trains the world's military forces and forges close ties around the world. The cyberworld emerged so did cyber terror and crime more spending. The Chinese exploded a weapon in space, more spending. Non-state asymmetric actors, more spending. Unsecured nuclear weapons, more spending. Bio-terror more spending. A war that decimated our Army in terms of modernization put on hold, more spending.
what GDP growth rate did you use in your estimation? Guess I missed it.. or do you assume that the GDP is at the current level, i.e. negative gdp real growth?
Too bad the data on your graphs didn't go back to the Reagan and two prior Bush administrations. I can understand why you didn't:
From wikipedia: Here is a wikipedia finding:
By tenure, the largest increases in gross debt relative to GDP, to date, occurred under George H.W. Bush (+11.2%), George W. Bush (+11.9%), and Ronald Reagan (+18.5%).
Here is the data by tenure of office; what it shows is that Republican tax cuts increased the deficits:
http://en.wikipedia.org/wiki/National_debt_by_U.S…
Re: Clive Crook's statement:
I disagree with [Keith Hennessey's] insistence that the deficit problem is not taxes that are too low but spending that is too high. It is both.
As I've pointed out previously, there is a persistent, pervasive, and frankly moronic argument constantly put forth by those who oppose any tax increases as part of the solution to our long-term fiscal imbalance. They say essentially "The projected long-term fiscal imbalance exists entirely because of projected growth in spending on entitlements, therefore the solution should be entirely by reducing projected spending on entitlements".
This is moronic on two levels. One is because it ignores the question of what is politically feasible. But even putting that aside, it is simply irrational. It's like saying that if I've started gaining weight because I've become less active, the only way to stop gaining weight is to get as back to being as active as I was before, as opposed to consuming fewer calories or some combination of the two.
Or, to highlight the irrationality even more clearly, it's like telling someone who now has financial difficulty because he just lost his job that the only solution is for him to get back that specific job that he lost, as opposed to finding a different one (along with any other measures such as spending less in the meantime).
Just because a problem is created (or is projected to be created) by a change in X doesn't mean that the best solution is to reverse (or prevent) that change in X. To think one implies the other is simply irrational, not to mention at odds with the common sense we apply every day in our own lives.
It's actually like saying that the best thing to do is to go back to being active and it's actually not saying go get that specific job, it's saying get a job. And speaking of politically feasible, what level of taxation do you think can be pushed through Congress?
You are not getting my point (I'm not saying that to be snarky, just direct). Again, there is no reason to presume that if a problem is caused by a change in X, then the best solution is to reverse that change in X.
Re: your question, I don't know, but I can tell you one thing: The effective tax rate will not stay below 20% of GDP over the next couple of decades. No way, no how (with perhaps the highly unlikely exceptions of a complete economic collapse and/or massive monetization of our debt with all the wild inflation that comes with it). We will need to keep debt and deficits from rising to unmanageable levels, and there is just no way politically that we will make seniors sacrifice to the extent that they would have to to keep taxation below 20% of GDP.
So the only politically plausible solution to our long-term fiscal imbalance is a combination of tax increases and reductions in projected total spending, and the latter must include Medicare and probably also Social Security to a large extent.
And the longer the extremists of both sides obstruct any such compromise, the more our fiscal situation will deteriorate and the greater the ultimate pain will be for just about everyone.
So a big, sarcastic, angry "congrats" to the delusional ideological extremists who defeated the Conrad-Gregg commission because, per the left, it would lead to reductions in eligibility and/or benefit levels for seniors, and per the right, it would lead to tax increases. To those folks I can only say: Grow up. Face reality. Your ideal is simply politically implausible, and the more you obstruct, the more pain you will cause for us all.
Brooks,
You know I love you man but this is over the top. Currently receipts are at 14.5 percent of GDP and in 2008 they were at about 17.5. So 20% of GDP is already a substantial increase.
Second, you argue that spending reductions aren't politically feasible and thus we need tax increases. That's got nothing to do with your argument about because X caused the problem, we should fix X to solve it. Why is it that you view policy commitments as immutable? Said differently, let's say I tell my kid he can go to Harvard and I'll pay. Then my circumstances change and I can't afford it. What should I do? In my view, I tell him that he can't go and will need to go to a less expensive institution.
Coming soon from me, an article on how absolutely insane our current entitlement system is as a matter of equity, both horizontal and intergenerational.
It is entirely possible to balance the budget through a combination of returning to the pre-Bush tax code and reducing spending. This would have both spending and receipts in the 20 to 21 percent of GDP range.
So I disagree. To argue that tax increases are the solution, you must buy into the notion that from the already crazy high baseline of current spending, we must grow at nearly 5% nominal per year (as proposed in the President's budget).
Your analogy is interesting. I allow my spending to exceed my means so the best available solution is to go get a new job that pays more? Sorry, that's a crazy line of thinking.
The government didn't lose it's job, it went crazy with spending. You don't need to do anything more than look at the historical data to arrive at that inescapable conclusion.
You know I agree with you on the commission but we radically disagree I guess on the "necessary" size of government.
From my pov, the government could easily live at probably half its current size. Entitlement programs (beyond for the poor) don't need to exist. Many Federal departments could easily be abolished (education comes to mind immediately). To argue that it "needs" to be as big as it is is a political argument not a logical one.
Steve,
I think you’re great, too, but I gotta correct you on just about everything you’ve said.
Re: Currently receipts are at 14.5 percent of GDP and in 2008 they were at about 17.5. So 20% of GDP is already a substantial increase.
We are just starting to come out (hopefully) of a deep recession. The effective tax rate (revenues as a % of GDP) is not comparable to what it would be upon recovery. As you know, the historical average in recent decades has been significantly higher than 14.5%. See http://www.heritage.org/research/features/BudgetC…
Re: you argue that spending reductions aren't politically feasible and thus we need tax increases.
I didn’t argue that at all. As you know from elsewhere, I believe the opposite: reductions in projected spending will not only (eventually) be politically feasible, but it is implausible that such reductions will not occur. What I have said is (1) it is not and will never be politically feasible to solve our long-term fiscal imbalance entirely on the “spending” side (plus revenue growth just from economic growth) and avoid any increase in taxation via the tax code, (2) it is politically implausible that the effective tax rate will stay below 20% over the coming decades, given political opposition to the types and levels of spending cuts that would be necessary to keep our deficits and debt manageable, and (3) [my main point] it is nonsensical to say that just because the long-term imbalance is entirely attributable to projected increases in spending that the optimal solution must be to solve the problem entirely by reducing that projected spending. See my “gaining weight” analogy and my “job loss” analogy in my initial comment.
Re: Why is it that you view policy commitments as immutable?
That’s my view?? News to me. Actually I’ve always said the opposite, and I’ve even said that it is politically unrealistic for anyone to think we can deliver all the projected spending on entitlements in the coming decades. But whether or not it is politically plausible to solve the problem entirely by scaling back those commitments is a political question, not one of my ideology or my policy preferences or of what is good policy. I’m just saying that the politics make such a solution impossible, and that will be even more so – much more so – in the years and decades to come, as the 65+ percentage of our population grows substantially (they vote in disproportionately large numbers, and their benefits are huge issues to them).
Re: Coming soon from me, an article on how absolutely insane our current entitlement system is as a matter of equity, both horizontal and intergenerational.
You know I agree on means testing, increasing the retirement age, and all sorts of other means of reductions in projected spending on Medicare and Social Security. By the way, if you haven’t already seen it, check out http://voices.washingtonpost.com/ezra-klein/2010/… and http://voices.washingtonpost.com/ezra-klein/2010/…
It is entirely possible to balance the budget through a combination of returning to the pre-Bush tax code and reducing spending. This would have both spending and receipts in the 20 to 21 percent of GDP range.
If you mean mathematically, sure. If you mean it’s politically plausible to keep revenues from exceeding 21% over the coming decades, no way.
Re: To argue that tax increases are the solution, you must buy into the notion that from the already crazy high baseline of current spending, we must grow at nearly 5% nominal per year (as proposed in the President's budget).
I clearly didn’t say that tax increases were “the” solution; I said that it is politically implausible that tax increases won’t be part of the solution sooner or later. As for projected spending and the drivers, I assume you’re familiar with them. Seniors won’t be made to sacrifice enough that taxation stays at 21% of GDP or less over the coming decades. Just won’t happen.
Your analogy is interesting. I allow my spending to exceed my means so the best available solution is to go get a new job that pays more? Sorry, that's a crazy line of thinking.
Actually, what your description of my analogy bears no resemblance in any way to my actual analogy. My analogy was: “it's like telling someone who now has financial difficulty because he just lost his job that the only solution is for him to get back that specific job that he lost, as opposed to finding a different one (along with any other measures such as spending less in the meantime).” Not only was your representation way off, but you apparently missed the point, which was what I said immediately after: “Just because a problem is created (or is projected to be created) by a change in X doesn't mean that the best solution is to reverse (or prevent) that change in X.”
[continued...]
On the final graph, we're making a big deal about 2010 and 2011 increases when the 2009 number is so much lower than initially projected — why is the 2009 number so much bigger? Did the economy grow larger than forcast last year? Are we bemoaning stimulus spending for shovel ready projects that weren't quite shovel ready last year and thus just trying to ding this administration a second time for the same solutions that were voted on and approved last year? Shouldn't we be congratulating the administration and giving them all a bonuses for not actually spending dollars even though they were budgeted?
[...continued]
Re: You know I agree with you on the commission but we radically disagree I guess on the "necessary" size of government.
On what basis do you say that? Sure hope not based on what I’ve said about what is politically feasible and what isn’t, which was just political analysis, not an expression of my policy preferences. That said, I do prefer a combination solution to a purely spending-side solution, although I’d like to see a combination of reductions in projected “actual expenditure” spending and “tax expenditure” spending comprise the larger portion of the solution, with the smaller part “real” tax increases — increases in tax rates and/or creation of new tax(es) such as a VAT.
Re: To argue that it "needs" to be as big as it is is a political argument not a logical one.
If someone made that argument, it certainly wasn’t me.
Steve, what’s up with all these errors, man? Very unlike you.
Brooks,
Maybe this will help. I view 20 percent of GDP as a substantial tax increase from current law (as does the CBO when they argue that by letting the Bush and Obama tax cuts expire will produce revenues between 20 and 21 percent of GDP by 2020). My point is that that's already a major tax increase and I perceive you as arguing for tax increases on top of that.
If your political judgment is that seniors won't allow their benefits to be cut enough to hold spending near the 20 or 21 percent mark then by judgment is that the only way out of this is a financial crisis of some type. I further prefer the crisis solution to one in which we feed the beast because various constituencies insist on their place at the trough.
On the analogy, I guess I'll say "just because a problem was caused by X doesn't mean you shouldn't try to fix X before moving on to other potential solutions."
My perception is your logic goes like this.
1. Balancing the budget (or close enough) is a necessity
2. Spending cannot be materially reduced from the CBO/budget baseline because it is politically infeasible.
3. Therefore the bulk of the change will need to be through the form of higher taxes.
Please let me know if I've misrepresented the logic.
Where I disagree is on 2. I think we must, as part of a packaged solution, challenge the growth rates in Medicare and Medicaid. In your post you both say you are for this and say that it can't happen politically.
Perhaps I'm an idealist but I would like to go tilt at that particular windmill for a while before I surrender to feeding the beast more and more of our collective earnings.
Re: If your political judgment is that seniors won't allow their benefits to be cut enough to hold spending near the 20 or 21 percent mark then by judgment is that the only way out of this is a financial crisis of some type.
1)Do you think there is a decent (or even good) chance that a solution amid a crisis will prevent spending from rising above 21% over the coming couple of decades?
2)Do you think a crisis is more likely to produce that result than a negotiated solution (or series thereof) prior to a crisis?
3)Do you think that a crisis is more likely than not to increase the proportion of the solution that comes from the spending side?
My answers are:
#1: No, not even a decent chance.
#2: Probably not, but in any case not leading to a decent chance.
#3: Tough to know, but if I had to guess I’d say no, the opposite is more likely, partly because of the degree to which timing affects the level of pain and thus political difficulty: Immediate, large reductions in entitlements benefits, rushed to respond to a crisis, would be much more painful than phased in reductions. While abrupt increases in taxation are also more painful than if phrased in, the differential due to timing is less. Seniors would not have had time to plan their finances, and many seniors are more dependent on their benefits and a large, abrupt cut would have a greater adverse impact on them vs. the impact of abrupt tax increases, which would be probably be distributed progressively. Bruce Bartlett had one or two good columns/posts discussing this dynamic and arguing that the answer to #3 is clearly “No, the opposite. A crisis would lead to a shift toward a greater portion of the solution being tax increases.
Re: I further prefer the crisis solution to one in which we feed the beast because various constituencies insist on their place at the trough.
The question of what portion of incremental revenue received before a crisis will cause incremental spending rather than deficit-reducing is a very legitimate question and an important consideration. The “wait for a crisis” strategy (meaning refusing to compromise on taxation enough for the political process to produce fiscal responsibility prior to a crisis) may have the “benefit” (if one has that policy preference) of forcing a greater portion of the incremental revenues to be used for deficit-reduction. But this benefit would have to be weighed against the cost and risk of cost of allowing the fiscal imbalance to deteriorate further, resulting in greater sacrifices, ceteris paribus (and again, there is also the very substantial chance that tax increases would be a greater portion of the solution amid a crisis). And it’s a dangerous game to play for the sake of a solution more fitting with one’s ideology and/or which one believes would be somewhat better economics. The cost of the “waiting for a crisis” could be enormously terrible for pretty much everyone. And by the way, all of the above applies to those on the left who refuse to compromise sufficiently to avert a crisis (as in “No way I’m agreeing to cuts in social spending so that people can have more tax cuts / avoid their ‘fair share’ of taxes / etc.).
Re: On the analogy, I guess I'll say "just because a problem was caused by X doesn't mean you shouldn't try to fix X before moving on to other potential solutions."
It doesn’t mean you necessarily should, which is my point. Even if you can reverse X it doesn’t mean that reversing X is the best solution. The best solution could be to change Y – i.e., we may prefer changing Y to reversing X.
Re: my “logic”, no, you haven’t characterized it correctly and I haven’t said anything that indicated your characterization (I know it wasn’t intentional and I’m not offended, just speaking frankly).
Your #1 the “close enough” part is obviously true, although that’s almost by definition (“enough”). We need to reduce projected deficits such that debt-to-GDP at least stays manageable (i.e., doesn’t spiral out of control and/or drive interest rates sky high and/or cause interest expense to eat up much more of our budget). I don’t have a particular debt/GDP figure, but my guess is that we should at least try to keep it from exceeding around 80%.
Your #2 should be “Spending should and will be substantially reduced vs. projections for the next couple of decades because it is politically implausible that that will NOT happen, and I also would consider it NOT happening to be undesirable ideologically and possibly disastrous economically.
Your #3 should be “It’s politically plausible that the solution over time will be either skewed toward the spending side or skewed toward the tax side, or split about even. My preference, based on my ideological inclination and my general economic assumptions, is that more than half of the solution come from the spending side.”
As you can see, the opposite is more the case than your representation.
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Re: I think we must, as part of a packaged solution, challenge the growth rates in Medicare and Medicaid. In your post you both say you are for this and say that it can't happen politically.
I said that reducing the projected growth rates in Medicare and Medicaid can’t happen politically?? Where did I say any such thing?
Re: Perhaps I'm an idealist but I would like to go tilt at that particular windmill for a while before I surrender to feeding the beast more and more of our collective earnings.
Again, that strategy is not without cost and great risk, per my explanation above.
Brooks,
Thanks for clarifying your logic. My apologies for mischaracterizing. It's the danger for drawing inference from text. I guess I think the preferred solution can and should hold spending in the 20 to 21 percent range. As I've told you in other contexts, I think reasonable means testing of entitlements could accomplish this. Perhaps this is politically infeasible; but, as part of a larger solution, I think it should be tried.
Let me try some numbers on you.
Receipts in 2008 pre-crash 17.5% of GDP
CBO projected 2020 receipts 20.4% of GDP (assumes tax cuts expire)
CBO Spending projection 23.2% of GDP in 2020. As I recall it, the Obama budget is closer to 24%.
I therefore assume the gap between 17.5 and call it 23.5 is the gap to close.
If we allow all the tax cuts to expire, that brings receipts to 20.5 and covers about half the problem (as far forward as we can project at this point). If, per your number 3 above, you'd like spending to cover roughly half the solution, I'm having a hard time squaring that with your perspective that we cannot hold spending to 20 to 21 percent. If we cannot, then we are going to rely on taxes to do most of the lifting in terms of achieving balance.
I'm not opposed to tax increases from current law, it's tax increases from the CBO baseline that I oppose based on the relative share of taxes and spending. I see no evidence that government can restrain spending absent a Constitutional or financial constraint. I think we would have wound up with a much more expensive HCR bill than the one we saw had is not been for the large deficit.
Perhaps the way you think about it, you assume the 20.5 on receipts as the starting point. That would, of course, yield a different result. Even this would put you somewhere in the 21.5 to 22.0 range, given what you said in point 3 above.
Steve,
I'm speaking of the "long-term fiscal imbalance". That means going well beyond the next 10 years. Look out to 2030, 2040. We know the demographics, which are a major factor in seniors entitlements and thus projected spending, another obviously being rate of increase in the relevant medical inflation rate(s) applicable to Medicare and Medicaid benefiaries, so it's not useless to look out 20 or 30 years, even though the magnitude of GDP growth is highly uncertain over that period.
OK, now I see the difference. I regard any projection of 2040 as no better than me pulling a number out of the random number generator. I'd be happy to achieve balance by 2020. It would provide us with some degrees of freedom.
I get the Medicare issue going forward but my perspective is those projections are just silly and won't happen because they can't.
I also suspect the relevant medical inflation rates are only relevant to a point. At some point, we will simply be forced to ration more. We can make that decision sooner (easier) or later (harder) but we will have no choice but to make it.
I agree with the degree of uncertainty with long-term projections, but I would disagree with disregarding longer-term projections in our fiscal policy choices today and in coming years. We do at least know the demographics, one of three key factors, and at least we could consider best guess estimates for GDP growth and medical inflation along with ranges ("high" estimate: "low" estimate) per sensitivity analysis. I'd rather do that, cognizant of our assigned probabilities of different ranges around our estimates, than not consider such projections at all.
That said, achieving a balanced budget on a structural basis (i.e., leaving aside the highs and lows of economic cycles) by 2020 would mean a declining debt/GDP ratio (since debt would not be growing but GDP would be increasing), which would increase the amount of slack we have for upward pressure on spending due to the demographics beyond 2020. Obviously magnitudes matter, so it would be useful to estimate what debt/GDP would be in 2020 per your plan, and then to do scenario analysis with various economic, fiscal policy, spending and revenue assumptions to see what would happen to debt/GDP over the subsequent decade or two in each scenario.
I agree we will bring down Medicare spending vs. those long-term projections, probably in a variety of ways including rationing* and other means — again, if you haven't checked out Paul Ryan's plan, check it out; I think it's basically capping government's spending per beneficiary via a voucher and shifting increases in medical costs to the beneficiary. But much of this spending reduction is part of the reductions in projected spending that you are talking about — part of that "half" of the solution coming from the spending side.
* I should say more rationing, since I'm guessing there are already authorizations required for coverage for some treatments, etc. under Medicare, which would mean there is already rationing (if my guess is correct).
George Will yesterday on Paul Ryan's plan http://www.washingtonpost.com/wp-dyn/content/arti…
Ryan's plan is interesting in some regards and much less so in others.
The best part of the plan is it results in a long term balance which makes it the only plan I've seen that does so.
The worst parts about it are the "assumption" of 19% in tax receipts which looks a bit inconsistent with the policy prescriptions and the fact that it takes so long to get to balance. His solution is far enough in the future that many things could change before he gets there.
That said, for all the many critiques of the Ryan proposal, it seems at the moment to be the only one that adds to zero at any point in the future.
I agree with Ezra Klein that Ryan deserves credit for at least putting something out there that gets somewhere. I'm not well-versed in his plan, but per Ezra Klein, CBO scored it, so it's apparently not just a bunch of vague concepts without any idea of budgetary impact. Robert Samuelson, in his column today, also separates out Ryan: "It's also true that Republican presidents and congressional leaders (some exceptions: Rep. Paul Ryan and Sen. Judd Gregg) have ducked the hard questions." http://www.washingtonpost.com/wp-dyn/content/arti…
The politically problematic part I see is probably the key to the whole thing: his capping of Medicare benefits per beneficiary by a particular dollar amount (albeit somewhat means-tested) via a voucher, thus shifting any additional costs to beneficiaries (seniors). The only thing that makes it possibly above a complete non-starter politically is that this structure wouldn't apply to anyone 55 or over, the people with these benefits most on their minds.
Steve,
FYI, Fareed Zakaria's solution http://www.cnn.com/2010/OPINION/02/04/zakaria.bud…
Brooks,
It's really too bad. His solution is to raise taxes by and large.
Eliminate tax deductions, raise rates maybe tinker on the margin with SS (BTW, he clearly buys the canard that SS solvency is a relevant discussion) and problem solved.
He doesn't provide any numbers so I can't judge whether it actually balances, but, if it does, it sounds like it balances with the Feds taking 23 or 24 percent of GDP. Not a solution I'd like very much.
As I think you know, the pervasive, fundamental conceptual confusion over SS "solvency" is a pet peeve of mine on an intellectual level and in terms of frustration that so much related discussion is on a completely irrational basis. And it's not just limited to discussion directly-related to how much Social Security contributes to our overall long-term fiscal imbalance or whether we should raise FICA SS taxation or reduce benefits and/or eligibility as we try to solve our fiscal imbalance problem; it also worms its way into consideration of other policies. For example, many say that the best kind of tax cut for immediate stimulus is a cut in payroll taxes, but I've heard people argue that we can't do that, because that would adversely impact Social Security's "solvency". But I've seen a lot — a lot — of very smart people stuck in that irrational conceptual and analytical framework re: SS. It doesn't help that there are experts out there abusing the credibility they have as a function of their expertise to perpetuate this confusion — e.g., Dean Baker, whom, as you know, Stan Collender recently applauded for a snarky comment on this issue (Is there an economics blogger of the left that Stan hasn't applauded recently?)
Re: numbers, I hope that the various non-governmental commissions (Peterson-Pew; Bipartisan Policy Center; any others), and White House-initiated commission if one is created, at least lay out some alternative solutions that are credibly scored (preferably with at least one version of scoring using a prudent application of dynamic analysis) and add up to projections of debt/GDP, deficits, and impact on growth that would be fiscally responsible and that would be as close as possible to something politically feasible someday soon.
Brooks,
I think the only realistic solutions involve either
1. Capping (hard or soft) Medicare costs per beneficiary.
2. Dramatically reducing the base (via means testing)
3. Both 1 and 2.
Ryan's plan is an example of 1. Personally I favor 3 but with a good chunk of 2 in the mix because 2 is what makes a difference in the short to medium term
Ryan's plan at least applies means testing to do #1. I don't know whether or not the means testing goes as far as to eliminate eligibility for some altogether (reducing the number of beneficiaries). I think it also increases the retirement age, with is the other way of reducing the number of beneficiaries).
Regarding your #1, perhaps part of the solution will be a cap per beneficiary (what do you mean by "soft cap" — different levels for different people? some types of exceptions?). Probably rationing via both direct means (more denials by Medicare of authorization for requested treatments) and indirect means — (1) changing the basis of provider compensation in ways (capitation, bundling, etc.) that incentivizes them to provide/prescribe less [or less expensive] healthcare (or looked at from the other side of the coin, incentivizes them less for providing/prescribing more healthcare) and to say "no" to the patient more often, (2) reducing compensation of providers and manufacturers of drugs and medical equipment with the drawback of less quantity and quality, and (3) probably more that doesn't come to mind at the moment. There are some good papers on the subject (available online) by think tanks and coalitions of think tank members.